Cyclical Sector Shifts Could Put Industrial ETFs in the Lead

Defensive sectors had been leading the rally in 2013 but the winds changed in recent weeks. If the shift to cyclical sectors continues, manufacturing and industrials exchange traded funds could move into high gear.

Currently, the Industrial Select Sector SPDR (XLI) has been falling behind the broader markets, returning 11.6% year-to-date, compared to the 14.0% performance of the S&P 500.

Investors have poured into non-cyclical stocks as an alternative to the historic low yields in government debt.

“They appear to be favoring less-risky cohorts – continuation the trend that has lasted for some time and one we think will remain driven by quantitative easing,” Morgan Stanley’s Adam Parker said in a research note.

“The main subsectors covered in this ETF are aerospace and defense firms, machinery companies, industrial conglomerates, and transportation companies,” according to Morningstar analyst Robert Goldsborough.

Additionally, XLI includes many quality brands with a large global footprint.

“Sector SPDR ETFs are very high-quality because they draw from the S&P 500 Index and have a very large-cap tilt. So XLI has a very high-quality portfolio,” Goldsborough added. “The industrials sector is cyclical, but many of the companies it holds have significant sales outside the United States, giving this fund some exposure to global growth trends.”

The top companies in the fund include General Electric 11.7%, United Technologies 5.5% and Union Pac 5.1%.